Are RIAs ready for the alternatives surge?

Are RIAs ready for the alternatives surge?

That’s a tough but fair question considering the tidal wave of new private market products hitting the market. And especially when the majority of RIAs are staffed by less than a handful of people with minimal experience in evaluating alternative investments.

“Too often, they are relying on the marketing from the issuer and third party reports from firms like Mick, Buttonwood and Fact Right. While these third party firms do their best, they sometimes get it wrong, and it is the RIA and their clients that get left holding the bag,” said Ed Cofrancesco, CEO of International Assets Advisory.

As a result, Cofrancesco believes that only the RIA is in a position to truly evaluate if the investment is suitable for their client. And that due diligence takes manpower which is not always available at smaller firms. 

Similarly, Jeff Schwartz, president of MPI, feels most RIAs are not adequately equipped for the surge in private market assets, and many are underestimating the requirements to offer them.

“There are definitely RIAs that we've worked with that are doing really solid work here but the majority are not prepared. Not having technology that is specifically tailored to alts is a big hindrance here,” Schwartz said.

Britt Whitfield, executive managing director with Callan Family Office, agrees, saying that given the vast number, type, and geography of non-traditional investments, a considerable amount of resources and expertise is required to conduct effective due diligence. And beyond manager selection, he believes the timing of capital deployment adds another layer of complexity. 

“Private capital commitments are typically called and invested over multiple calendar years, which requires careful research, pacing plans, and monitoring to manage exposures over time. Developing a thoughtful approach to modeling and staging these commitments is essential to avoid over- or under-allocation relative to client objectives and to maintain the desired portfolio profile through market cycles,” Whitfield said.

Avoid risk but meet demand

With clients increasingly pushing for access to alternatives, RIAs are being forced to balance meeting that demand against the risks of insufficient due diligence.

In Cofrancesco’s opinion, if the RIA elects to incorporate alternatives into the investment practices, they need to seriously commit to developing the expertise and the resources to perform proper due diligence. If not, they should at least be honest with their clients about their limitations. 

“Simply putting clients into broad based alt funds manage by large institutions is not a solution. The reality is that these types of funds have too many layers, and thus additional costs, between the investor/investment and the actual use of funds,” Cofrancesco said. 

And while the funds may be safer than individual alt investments, Confrancesco believes there is a plethora of research demonstrating that these types of funds underperform broad equity markets indexes such as the S&P and are not truly uncorrelated to general market condition.

In Schwartz’s view, only RIAs with experienced home office research and due diligence teams should be looking at individual hedge funds, private equity, and the like, not to mention the expensive tools that are typically needed to properly analyze such products.

“Given that, the majority of RIAs should instead be looking more to liquid alts with their lower fees, transparency and greater liquidity,” Schwartz said.

Whitfield points out that the risks of poor or even mediocre due diligence can have a material impact on investment performance within alternatives. Historical data shows that performance dispersion among alternative managers is far wider than in public markets. 

“In a study comparing returns of public market active managers with those of alternative managers - private equity, private debt, real estate, and hedge funds - the results were striking. While the average return spread between top- and bottom-quartile public market managers was 1.5%, the spread widened to 10% for alternative managers, with private equity exhibiting the greatest dispersion at 19%,” Whitfield said.

Whitfield adds that the need for deep resources to properly perform due diligence across a wide landscape of alternative investments may in fact be one of the reasons behind the consolidation in the RIA industry in recent years. 

“Several RIAs have merged with institutional consulting firms, gaining access to experienced due diligence professionals and enhanced research capabilities. For many firms, this provides an immediate upgrade to their investment process. Third-party platforms such as iCapital, CAIS, and others have also expanded significantly over the past decade, providing RIAs with easier access to alternative investment opportunities,” Whitfield said.